The effect of profit warning announcements on the share returns of firms listed at the Nairobi securities exchange

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Abstract

Profit warning announcement forms an integral part of mandatory disclosures that are
set up by the regulatory bodies. The capital markets have evidenced immerse growth
and innovations that have led to more stringent measures being put in place to prevent
insider trading and fraud cases. The disclosure of the profit warning aims to ensure
transparency and information asymmetry in the securities market. When there is
material expected negative deviation of profits compared to the previous period firms
have an obligation to inform the shareholders and the public at large. The profit
warning announcements have being associated with a negative market reaction and
huge abnormal returns. This study examines the effect of profit warning
announcements on the share returns at the NSE. The report is based on the 64
companies listed at the NSE and 16 sampled firms drawn from companies that have
issued profit warnings for the period 2015 to 2016. The research design used was the
event study using the market model which assessed the impact of announcements on
the returns. The event window is twenty one days (-10,+10) and an estimation period of
30days. The CAPM model was used to estimate the expected returns. The CAR during
the period amounted to -7.24%. The AR and CAR were plotted on a graph and there
was a downward trend after the announcements showing the negative market reaction.
The mean of the abnormal returns was -1.21% while the standard deviation was 4.80%
the day after the event. The CAR mean was 3.83% and the standard deviation was at
18.17% the day following the announcement. The regression analysis indicated that the
independent variable which is the market return can only explain and predict shares
return during profit warning announcements by 6.72%. The study concludes that profit
warning announcement has a negative impact on the shares return at the NSE. This is
evidenced by the negative abnormal returns realized and the test of significance using F
statistic which is at 0.94.The study recommends firms to give more details in the profit
warnings in order to inform the shareholders on the causes of the deviations in earnings.
Further, the study recommends that regulatory bodies should put more stringent
measures to avoid insider trading and ensure that there is no leakage of information.
Further areas of study include the factors influencing the issue of profit warnings by
firms and measures taken by firms to reduce earning deviations in the subsequent years.